Economics 323: Finance Theory and Applications Wellesley College Fall 2008 Eric Hilt Department of Economics PNE 411 Email: ehilt@wellesley.edu Office hours: Mondays, 1:00-2:00 PM; Wednesdays, 2:00-4:00 PM; and by appointment Class Time and Location Mondays and Thursdays, 9:50-11:10 AM, in PNE 339. From time to time it may be necessary to start a little early, in order to provide for time for exercises and discussion in class. As we will frequently do quantitative exercises together in class, please bring a calculator. (It does not need to be a fancy one.) Course Description This course provides a rigorous treatment of the fundamentals of finance. The prerequisites for this course are Econ 201 and 203. We will consider: the interpretation of financial statements; the valuation of distant cash flows; the valuation of financial instruments such as stocks, bonds and options; and the financing and investment decisions of firms. Wherever possible, we will study modern academic research that relates to the topics of the course. But the relevance of the methodologies and research you will study in this class is not purely academic: unless you understand finance, you cannot understand a company s decision-making process thoroughly. This course will thus introduce you to the operations of the companies you will encounter in your role as employee or consultant or investor. Readings The required textbooks are Ross, Westerfield and Jaffe, Corporate Finance (8th ed.), and Bodie, Kane and Marcus, Investments (8th ed.), available at the Wellesley bookstore. Many of the readings assigned for this course will be from these textbooks, but various additional materials will be distributed in class, or made available in the library or the course conference. For those students interested in learning accounting in more detail, some additional readings (not required) can be found in Kim and Siegel s Schaum s Outline Of Theory And Problems Of Financial Accounting, which is available as an e-book. There is a link within the Wellesley library catalog, but the URL is: http://0-site.ebrary.com.luna.wellesley.edu/lib/wellesley/doc?id=5004742
Other readings, such as articles from finance and economics journals, will be posted to the conference or distributed in class. These readings will also be a required part of the course. Finally, I recommend strongly that you follow current events in business and financial markets by reading the Wall Street Journal (but ignore the editorial page). Conference Problem sets, solution sets, and other materials will be posted on the course conference, ECON323-F08. Please add this conference to your FirstClass desktop. Assignments Five problem sets will be assigned. Some will resemble problem sets from other economics classes (you ll receive a series of problems to solve), but others will involve hands-on analysis of data. There will also be a portfolio-picking assignment that lasts throughout the semester. The assignments will be collected at the beginning of class on the date they are due. Late assignments will not be accepted. Exams and Grading There will be two exams in this course: an in-class midterm, and a final. The midterm will be Thursday, November 6. Treat the date as you would an important meeting in the business world absent some dire emergency, you must be there. No make-up exams will be given, unless you inform me of a schedule conflict immediately. The self-scheduled final exam will be comprehensive. Problem sets and exams will count toward the grade as follows: 1. Assignments, 25% 2. Midterm Exam, 30% 3. Final Exam, 45% I may (on an individual basis) adjust the weight applied to the final to reward improved performance. Some Advice This is a hard class. Although some of the material is relatively elementary, we will encounter some very challenging topics, and we will proceed through them at a gruelling pace. As much of the material is cumulative in nature, it is important that you keep yourself from falling behind. If you have trouble with some of the material, please come to my office hours for help. In my experience, the best way to learn finance is by doing it. Therefore, in addition to the assigned problem sets, I will distribute a number of supplemental exercises, with solutions.
Before the exams, I will also distribute sample problems with solutions, and I recommend that you do not look at the solutions when you try to solve the problems. Many of the problems will look easy once you have seen the solution; it is important that you gain the experience of trying to figure out how to solve the problems. Students frequently ask for advice when preparing for exams, given the enormous volume of material covered in the course. It is important to keep in mind that the exams will focus on the fundamental concepts and the subjects covered in great detail: there will be no surprise questions based on obscure and unfamiliar material. Class Schedule RWJ denotes Ross, Westerfield and Jaffe, Corporate Finance; BKM denotes Bodie, Kane and Marcus, Investments; and FA denotes Kim and Siegel, Theory and Problems of Financial Accounting. Required readings are denoted with an asterisk [*]; readings without an asterisk are not required. Part 1: Financial Statements and Accounting Data September 4 September 8 September 11 September 15 September 18 Introduction to financial markets. *RWJ, ch. 1 *BKM, ch. 1 Math review. Basic finance concepts. Introduction to accounting data and the principal financial statements *RWJ, ch. 2 FA, ch. 2 Financial statements: the balance sheet and income statement *RWJ, Appendix 2A BKM, ch 19 FA ch. 3 Problematic areas of accounting rules and financial reporting *Reading Packet: Accounting FA ch. 6, 8, 9, 10
Part 2: Valuation September 22 September 25 September 29 October 2 October 6 Present Value (PV) concepts; the Efficient Markets Hypothesis (EMH) *RWJ, ch. 4 *BKM, sec. 12.1 Fixed-income securities *RWJ, sec. 5.1-5.3 RWJ, ch. 20 Fixed income and interest rate sensitivity: duration and convexity. Review of Excel. *BKM, ch. 14; sec. 16.1-16.3 The term structure of interest rates *BKM, ch. 15 The term structure of interest rates, continued *BKM, ch. 15 Part 3: Uncertainty, Risk and Asset Prices October 9 October 16 October 20 October 23 October 27 October 30 November 3 November 6 Expectations, uncertainty, and risk aversion *BKM, ch. 6 Risk, return and the allocation of capital: portfolio choice with one risky asset. *RWJ, sec. 10.1-10.7 *BKM, ch. 7 Many risky assets: the two-fund theorem and optimal portfolios. *BKM, ch. 8 Optimal portfolios, cont d. *BKM, ch. 8 Market equilibrium and the capital asset pricing model (CAPM) *RWJ, sec. 10.8-10.9 *BKM, ch. 9 The CAPM, continued. Investor behavior and behavioral economics. *BKM, ch. 12 Review Midterm Exam
Part 4: Investment and Financing Decisions November 10 November 13 November 17 November 20 November 24 December 1 December 4 December 8 The financing decision: capital structure *RWJ, ch. 14,19 RWJ, ch. 20 The investment decision: risk, capital structure and capital budgeting *RWJ, sections 6.1, 6.5, 6.6; ch. 12 Capital structure and firm value *RWJ, ch. 15 Agency costs and capital structure: limits to the use of debt *RWJ, ch. 16 Capital structure and investments: Capital budgeting for the levered firm *RWJ, ch. 17 Capital structure and investments, continued *RWJ, ch. 17 Dividends and firm value *RWJ, ch. 18 Review